The Curse Of The Euro: Money Corrupted, Democracy Busted

The preposterous Gong Show in Brussels over the weekend was the financial “Ben Tre” moment for the Euro and ECB. That is, it was the moment when the Germans—–imitating the American military on that ghastly morning in February 1968——set fire to the Eurozone in order to save it.

Some day history will judge good riddance……..but that get’s ahead of the story.

According to an American soldier’s first hand recollection of the Vietnam event, it was a Major Booris who infamously told reporter Peter Arnett, “It became necessary to destroy the town to save it”. 

After the massacre of Greek democracy in the wee hours Monday morning, Angela Merkel said the same thing—even if her language was a tad less graphic:

It reflects the basic principles which we’ve followed in rescuing the euro. It now hinges on step-by-step implementation of what we agreed tonight.”

Now no one in their right mind could think that lending another $96 billion to an utterly bankrupt country makes any sense whatsoever. After all, the Greek economy has shrunk by 30% since 2008 and is wreathing under what is objectively a $400 billion public debt already in place today.

That figure follows from the fact that on top of Greece’s acknowledged $360 billion of general government debt there’s at least another $25 billion loan embedded in the ELA advances to the Greek banking system. The latter is deeply insolvent, meaning that some considerable portion of the $100 billion ELA currently outstanding is not an advance against good collateral in any plausible banking sense of the word, but merely a backdoor fiscal transfer from the ECB to keep Greece’s financial shipwreck afloat.

Likewise, as I demonstrated Friday, given the even deeper deep hole into which the Greek economy has tumbled during the last six months, the fiscal targets extracted from Greece under this weekend’s demarche are utterly ridiculous. Indeed, even if the targeted primary surpluses of 1,2,3 and 3.5% of GDP are miraculously reached through 2018, upwards of $15 billion of budget deficits after interest accruals would be incurred anyway, and a lot more than that if there are material budget shortfalls, which is a virtual certainty.

So even before the latest dose of Troika economic punishment further debilitates its economy, Greece at this very moment has a de facto public debt of $400 billion sitting atop $200 billion of GDP.

Here’s the bottom line. Merkel has no better answer for how dropping $96 billion of new debt on a country with a 200% public debt ratio will save the euro than did Major Booris when he dropped approximately 10,000 gallons of napalm on Ben Tre in order to “save” the town. In both cases, a doomsday machine had been set in motion, and the designated officers of the state mechanically and blindly carried out a mindlessly destructive next step.

In the instant case, the doomsday machine is the Euro and, more precisely the rogue central bank in Frankfurt that stands behind it. In fact, the real ill is not a common currency per se—-something that Europe actually had on a de facto basis before 1914 under the fixed exchange rates of the gold standard. The latter, in effect, was a common currency because French francs, British sterling, Dutch guilders and the rest were interchangeable at a constant rate—-an arrangement which helped produce a multi-decade spurt of prosperity that the old continent has not seen before or since.

No, the problem is the rampaging printing press of the ECB. The latter has fundamentally falsified the price of debt, and thereby unleashed throughout Europe a deadly brew of phony economic growth in the early years and then egregious fiscal profligacy when the growth bubble cratered after the 2008 crisis.

During its initial eight years, the ECB expanded its balance sheet at a torrid 14% annual rate. And that’s ironic because the original remit of the ECB was a Friedmanesque “price stability” single mandate.

Historical Data Chart

That didn’t happen, of course, as the European consumer price level rose by 21% during the same eight years (2.4% per annum) in which the ECB’s printing press was running red hot. Uncle Milton would have been rolling in his grave, and, in fact, beforehand had pronounced the euro a disaster waiting to happen.

So rather than delivering consumer price stability, what the ECB actually did during that period was to create a giant artificial bid for euro debt, thereby driven the yields far below their true economic levels. That is, the ECB deeply subsidized newly issued Eurozone government borrowings.

Not surprisingly, Greece, Portugal, Spain, Italy and even France feasted heartily. But then Europe’s phony credit fueled growth stopped, causing the nominal GDP growth rate to decelerate sharply.

Since the eve of the financial crisis, nominal GDP in the Eurozone has crawled forward at a mere 0.9% annual rate. That represents a 75% reduction from the pre-2008 rate and is a reflection of the crushing burden of debt, taxes and the dirigisme of the Brussels superstate and national policies alike.

Accordingly, it quickly became evident that Europe was swimming naked as a fiscal matter, and that the ECB’s cheap money regime had eviscerated the 60% debt-to-GDP target of the EU treaty. Even after averaging in the fiscal rectitude of Germany and some of its northern compatriots, the EU-19 debt ratio has climbed steadily toward the 100% of GDP mark since the financial crisis.

Historical Data Chart

What was needed all along was an honest bond market, and one which priced the debt of each of the 19 fiscal jurisdictions in the Eurozone based on their own budget facts, economic trends and governance records and risks. That requirement almost materialized when the original Greek debt crisis broke out in 2009-2010, and the yields on the so-called PIIGS debt soared.

But that proved to be the last gasp of a real bond market because in short order Brussels and Frankfurt shut it down in the name of defending the misbegotten euro. This bond market destruction effort took the form of a double whammy of falsification.

First, a false debt sequestration chamber (i.e. the various bailout funds) was erected by Brussels and the IMF and into it was stuffed hundreds of billions of the sovereign debt of Greece, Ireland, Spain and Portugal. This occurred during 2010-2012 when PIIGS debt was being dumped furiously, and appropriately so, by European banks, bond funds and financial speculators as the extent of fiscal breakdown in these states became sharply apparent.

In hindsight, this original euro bond crash was a gift from the economic gods. That’s because facing a closure of the public debt markets, each of the PIIGS would have had to work out its own internal fiscal solvency plan without edicts, mandates, inspectors, and meddlesome interventions from the troika apparatchiks, and without the incremental “bridge loan” debt that these bailouts entailed.

Stated differently, bond market discipline is fully compatible with national sovereignty and democratic fiscal government, Indeed, it is a requisite in the European context.

As it happened, however, Merkel was hoodwinked into believing that the original bond sell-off was the work of the same malevolent Anglo-Saxon “speculators” who purportedly caused the great financial crisis of 2008. So the EU superstate, she was told, had to take on the job of “banker” to the fiscally weaker members of the monetary union in order to buy time, defeat the speculators and preserve the financial stability of the Eurozone.

Unfortunately, Merkel and her coterie are monetary ignoramuses and therefore bought this tommyrot hook, line and sinker. So doing, they were utterly blind to one glaring reality. Namely, that the crashing global credit bubbles of 2008 and the euro bond crash of 2010 and after had the same cause.

In both instances central bank financial repression had caused government bonds to be underpriced and global investors to desperately scramble for yield (including exotic securitized mortgage product in the first instance and PIIGS bonds in the second). It also enabled Wall Street and London speculators to surf these financial bubbles on the back of cheap carry from the central bank pegged money market. So doing, the speculators were able to buy hand over-fist those securities which were rising and then sell with a vengeance these same mis-priced securities when the various bubbles burst.

In short, the desperate need back then was to shutdown the heavy-handed Keynesian central banker intrusions in the debt and money markets; permit the issuing governments to default; require the imprudent bankers holding the impaired debt to take steep losses; and to thereby put the bond market vigilantes back in charge of public fiscal discipline—–one state at a time.

Needless to say, the troika bailouts had the opposite effect. By compressing bond spreads toward a German common denominator, they destroyed price discovery and national fiscal sovereignty. The troika bankers, therefore, had to become heavy-handed agents of fiscal governance, meddling in the minutest details of national fiscal accounts; and, also, self-appointed economic reformers intruding into the very warp and woof of domestic commerce and labor and product markets and practices of the borrowers.

This massive intrusion was necessary in order to cover-up a Troika lie and delusion. The lie was that the debt of Greece and the other PIIGS was not being mutualized, and that the loans and guarantees issued by the bailout funds were first cousins to commercial bridge loans that the borrowers would in due course repay.

In the same vein, the delusion was that the market oriented “reforms” stipulated by the Troika would unleash higher GDP growth rates among the borrowers, thereby permitting them to grow out from under their Troika bridge loans after a period of externally enforced fiscal retrenchment.

This means that the Troika MOUs were not based on the assumption that “austerity” per se was a policy tonic. That charge is just a Keynesian canard that has gotten endless resonance in the financial press—–as in MarketWatch’s specious headline this morning proclaiming, “Greece offers evidence that austerity doesn’t work”.

Actually, it proves nothing of the kind. What it does prove is that superstate bureaucrats operating by dictate and remote control cannot reengineer national economies sufficiently to meaningfully elevate economic growth rates; and to thereby enable fiscally insolvent state borrowers to grow out from under their unsustainable debts. Indeed, that is just a variant of the supply side delusion of GOP orators in the US.

To some considerable degree this Europeanized form of the Laffer Curve was the subtext during last weekend’s Gong Show of political bullies, economic ignoramuses and superstate apparatchiks in Brussels. Here’s how they finally instructed the hapless Greeks to manage their crushing $400 billion of debt. Why among other things, their final missive required:

…….adopt more ambitious product market reforms with a clear timetable for implementation of all OECD toolkit I recommendations, including Sunday trade, sales periods, pharmacy ownership, milk, bakeries, [over-the-counter pharmaceutical products in a next step], as well as for the opening of macro-critical closed professions (e.g. ferry transportation)…….

If your weren’t aware of the Troika’s grow-your-way-out-of-debt delusion you would think this whole thing was some kind of giant hoax. After all, is it really possible that the assembled might of 327 million citizens of the Eurozone-18 are telling the 11 million inhabitants of Greece that they must open the restricted professions of engineers, notaries, actuaries, and bailiffs, and must liberalize the market for tourist rentals and ferry transportation.

Or that they are also being told exactly how to reform their utility capacity based payments system and other electricity market rules. And this is being ordered so as to avoid  the deadweight economic losses which occur when electric power plants operate below their variable costs or netting of the arrears between power provides and the utility distribution system provides erroneous economic signals, among other things.

In the same vein, there are edicts to alter the operating specifications for running a bakery, the rules for owning a pharmacy, the methods by which milk is sold and marketed, and it get crazier from there.

The rationale for all of this mind-boggling meddling in local commerce and economic life, of course, is the Laffer Curve. The Greeks are to be jack-hammered into more market-oriented economic habits so that Greece can grow its way out from under its debt and thereby become a sturdier debt mule while under the Troika’s ministrations.

That’s all absurd of course. But it’s what happens when a superstate becomes a fiscal banker and lies to its constituencies about the financial costs and risks of underwriting what were plain old bad debts in the first place. Indeed, when you destroy honest bond markets you eventually end up with Stalinist governance in the name of the free market!

The implications of that truth are doubly ironic. First, the real policy of the Troika was not “austerian” as gas-bags like Professor Krugman constantly importune; as indicated, it is actually a European version of the Laffer Curve—–that is, fiscal redemption through supply side magic and a bigger denominator of GDP to generate incremental tax revenues and thereby shrink the ratio of debt to national income.

The second irony is that almost all of the labor and product market reforms advanced by the Troika are good free market concepts that would enable greater efficiency and productivity over time, and thereby stimulate a larger pie of national income. However, the skunk in the woodpile is that the crypto-communist labor laws of Italy and Spain and the crony capitalist product market cartels and restrictions which thwart efficiency in Greece and throughout much of Europe are for better or worse a product of the democratic process.

As free traders used to say about protectionist quota and tariffs, if some benighted parliaments abroad decide to fill their harbors with rocks in order to keep out cheaper foreign goods that is their right to be stupid; it does not warrant closing American harbors in response and thereby punishing domestic consumers and markets in retaliation.

Yet, by the same token, the domestic stupidity that causes the Greek parliament to hang on to retail trade restrictions that prohibit price discounting and competition except during specially designated winter and summer “sales periods” does not justify the preemption of domestic legislative sovereignty. If the Greeks wish to legislate themselves into a lower standard of living in return for the perceived social stability and benefits of dirigisme—-that is their democratic prerogative.

Stated differently, the Eurozone is fatally flawed monetary union; it is not a sovereign state with plenary Federal preemption. Therefore, the Brussels conceit that it can be a Laffer-Curve style banker to the PIIGS is fundamentally mistaken. If any sovereign state of the EU can’t pay its debts, those debts need to be written off or restructured. With the passage of time and the trauma of realized losses in the government bond markets, there would be less debt issued and more fiscal rectitude apparent even among social democracies of the old world.

Unfortunately, the Franco-German alliance that has driven the EU bailout regime has now dug itself into a deep corner of lies and delusions. What Greece does prove—-and Spain, Portugal, Italy, Ireland and France, too—-is that quasi-socialist welfare states in the contemporary European setting can never grow out from under excessive debt. Supply side reform is a snare and a delusion into terms of debt carrying capacity, and is political dynamite if coercively imposed from above via superstate preemption of domestic governance.

All of this should have been apparent from the get-go, but is surely evident now after a half-decade of failed Troika bullying. But the Troika bankers-cum-reformers are now trapped because they have continuously lied to their own parliaments about the risk of the PIIGS bridge loans and the prior bailouts of the private investors who originally held their debts.

Were France to seek funding for the EUR 72 billion of Greek debt it has underwritten (including its share of ECB advances) or Germany the EUR 95 billion or Italy the EUR 63 billion or Spain the EUR 44 billion——governments would fall in no time. The incipient nationalist-populist uprising that is already roiling European politics would erupt into a stampede of upheaval.

And this is where the second falsification——Mario Draghi’s “whatever it takes” ukase—comes into the picture. The Eurozone would have blown to bits during the original 2010-2012 crisis, and notwithstanding the extensive bailout facilities, had not the ECB committed itself to massive monetization of the PIIGS debt—-debts that real investors did not wish to hold even at the elevated rates which materialized during the crisis. These soaring rates were indeed the off-ramp to bankruptcy because these states were, in fact, bankrupt.

Yes, it took nearly two years for the ECB to actually get its big fat $70 billion monthly bid into the marketplace. But that was immaterial. The fast money gamblers bet that the ECB would eventually commence a massive bond buying campaign and were more than happy to front-run the resulting euro bond bubble.

That the speculators who rode the Draghi bubble made hundreds of billions of profits buying PIIGS debt on 95% repo, and were then positioned to sell their bonds back to the ECB at the first sign of a market break, is a deplorable consequence of the ECB’s version of bubble finance. But the real ill is that the weak-kneed, hypocritical and often corrupt politicians of the peripheral countries were enabled to falsely claim victory without significantly rectifying their own fiscal insolvency.

Spain is the poster-boy on this front. After the mid-2012 Draghi ukase, it did not significantly shrink its state budget or reform its tax and regulation addled economy. By the end of Q1 2015 its real GDP was still 6% smaller than during early 2008. Accordingly, its debt ratio rose sharply and is now pushing up against 100% of GDP.

Historical Data Chart

Needless to say, the above blindingly obvious fiscal deterioration had no impact whatsoever on the pricing of Spanish 10-year bonds after the Draghi ukase. By the end of March this year the debt of the quasi-bankrupt Spanish state was trading at 1.0%, reflecting a blatantly artificial stampede of Spain’s public debt first into the hedge fund parking lots, and eventually into the vaults of the ECB.

There is no possibility of honest fiscal governance in a social democracy like Spain when its debt price is blatantly falsified per the above. Indeed, at this very moment the Spanish government is back into the market with a massive $15 billion issue, attempting to surf on the debt market wavelet generated by Monday’s Greek bailout headlines.

To be sure, the Keynesian commentariat and ECB apologists are now proclaiming that Spain is fixed——perhaps just like Greece was last August when its government issued 10-year debt at under 5%. The point is, however, that the modest rebound in Spain’s current account and uptick in its employment and GDP figures is a rounding error in the scheme of things. Another recession is surely coming to Europe, and perhaps sooner rather than latter. Since Spain’s budget deficit in 2014 was still 5.8% of GDP, how in the world will its fiscal accounts survive another recessionary blow?

They won’t. The Troika bankers will be all over Spain like a wet blanket, extinguishing another European democracy and fueling radical popular movements like Podemos—just as it has already done in Greece.

And a cascade around the European periphery of that mode of Stalinist governance may not be too far down the road. In a few days it will be blatantly obvious that the Germans have occupied Greece in every meaningful sense of the word save the actual bivouacking of uniformed troops.

A German/troika agent will place a custody lien on every airport, train station, port, power plant, electrical distribution grid, ferry boat, bus line, tourist attraction and public park, forest and island for which the Greek state still holds title. Even then, it will not amount to close to the $50 billion of collateral demanded.

Likewise, within days the entire banking system of Greece will be taken over by the ECB, meaning that depositors—-especially those above the EUR 100,000 guarantee threshold —–will be given a goodly haircut.

In short, Greece will become an outright debtors’ colony and its government will function as page-boy legislators for the Troika occupiers. Needless to say, political and social upheaval will erupt when the full extent of the Tsipras surrender becomes evident, and the resulting political contagion will spread throughout the length and breadth of Europe as Greece implodes.

In due course, the euro will collapse and the baleful Keynesian money printers regime in Frankfurt will be repudiated and dismantled. But not before European democracy has a brush with death, and European prosperity is extinguished for a generation.

By David Stockman
ContraCorner– July 14, 2015